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Raising wages or cutting taxes?

Posted on February 15, 2014 by Tom Healy

Tom Healy, Director NERI
Tom Healy, Director NERI

‘Putting more money into the pockets of consumers and workers’ Now who could be against that? ...after six years of unrelenting austerity, wage cuts for some, tax increases for nearly everyone …. But the problem is that ‘putting more money into the pockets’ can be done in a number of ways. Taxes on income can be lowered by one means or another. Or, wages can be increased. Creating new jobs will also help as people start earning and spending more.  However, there is a crucial difference between cutting income tax (always a popular proposal because nearly everyone in the income tax net believes they are paying too much already and would love to pay less) and raising wages. 

Raising wages is good for business, government and workers to the extent that it raises incomes and generates tax flows and higher demand for business goods and services bought in Ireland. At the same time it may not be so good for businesses in so far as an increase in wages for one firm or industry sector may put that firm at a competitive disadvantage vis-à-vis other firms/industries even though a general increase in wages would help stimulate demand in the Irish economy. Moreover, for a given level of turnover an increase in wages lowers profits. Profitability varies a lot from sector to sector and from firm to firm. Yet, the evidence that is available from Eurostat and the CSO (and some of which is summarised in the NERI Quarterly Economic Facts) indicates that Irish labour costs are not in excess of those in comparable European countries (the U.K. is, however, a relatively low wage economy in developed European economies). Moreover, patterns of Irish exports since the 1990s have been driven as much, if not more, by non-wage factors including product quality, currency value changes as well as structural shifts in the composition of production here [Refer to 'Wages and Ireland's International Competitiveness' by my colleague Rory O'Farrell]

An emerging consensus in  mainstream media and political commentary is that raising wages is not such a good idea and if it has to happen it should be carefully managed, controlled and limited to avoid ‘a wage explosion’ or worse still ‘anarchy’. Such claims are advanced with little regard for what is happening on the ground with incomes and wages.  Purveyors of the ‘wage explosion’ rarely produce the evidence that average wage are increasing in any sector or firm at a rate well in excess of the rate of increases in prices.  The most recent evidence on weekly pay indicates a small fall in real pay rates as measured by average weekly earnings when adjusted for inflation (by about 2.5% in the 12 months ending last Autumn).

Instead of raising wages, it is argued by some commentators that the sensible thing for Government is to cut income taxes. Various claims are made to that end:

  • Income taxes have increased dramatically in recent years
  • Income tax rates are among the highest in the world
  • The highest income tax rate kicks in at very modest incomes compared to other countries
  • Now is the time to bring back some stimulus into the economy which will help growth and ‘pay for itself’ (or almost)
  • People need a break anyway with prices and charges rising.

Space does not permit a critical analysis of these claims here. In the course of this year the NERI will continue to research the evidence on taxation, wages and income as it has done since its establishment two years ago. Suffice it to say that ‘there is no free lunch’. A reduction in taxes for some taxpayers means one of three things:

  • More taxes or charges in another part of your household budget (whether by way of other charges or costs associated with excise duty, VAT, property, water, public transport etc)
  • More taxes for someone else but not for you.
  • Less spending by the Government on the ‘social wage’ = early childhood care, social housing, education, community health care, libraries etc

So, choices have to be made. What is best? It depends on what sort of society we want. There is no point in blaming the Church, our former colonial authorities, the markets, the Troika, the EU, the banks, the unions, the employers, the public sector or the private sector. We have choices as well as real-world political constraints.  The choice on what level of public services is desirable and achievable is a political choice. One thing is certain, cutting taxes will cost just as with any other decision.  Suggestions that it will stimulate economic activity and, thus, pay for itself are unproven.

What should be done? Briefly I suggest –

  • Increase wages to stimulate demand.
  • Raise employer PRSI gradually over time to pay for the 'social wage'
  • Do not cut the overall level of income taxes for any income group (Ireland needs to increase taxes, not decrease them)
  • Raise further taxes ‘on the broadest shoulders’ as already argued for in the NERI Quarterly Economic Observers in 2012 and 2013 (average effective tax rates on the top 5% of households are below 40%).
  • Reform the tax code to make it simpler, more transparent and fairer (this could also mean raising the 41% income tax threshold for single persons on €32,800 per annum but in a way that does not lower the average tax bill for persons in this category).

There are two main ways Government extracts revenue to pay for public services and ‘social wages’

1 VAT/Excise duties and

2 Personal income taxes/PRSI.

Other sources of revenue (corporate, capital etc) are important and could be increased but the lion’s share of government revenue comes from 1) VAT/excise and 2) personal tax and social insurance.

Rather than cut into ‘social wages’ there should be an orderly, gradual and significant increase in wages to reclaim some of the lost ground and increased share of profits in national income since 2010. This should be weighted towards the lowest paid and most vulnerable.

The best way to assist young people to find work is to create a favourable environment in terms of domestic demand, adequately paid jobs and opportunities to advance their skills and experience in a way that is meaningful. 

 

 

Posted in: Labour costsTaxationWages

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